The post-Party Congress attempts to deleverage and crack down on the worst abuses in China's horrific credit bubble - especially the country's $15 trillion in wealth-management products - saw China's authorities turn their sights on shadow banking and wealth management products (WMPs) specifically. On their way out are "guaranteed returns" and "capital pools", which had turned the wealth management sector into a Ponzi scheme. In a radical and "shocking" departure from the historic norm, financial institutions will have to offer yields based on the risks and returns of the underlying assets.
As Citic' Ming Ming summarized China's shadow reform to Bloomberg, this is "the most comprehensive and most profound regulatory document ever. This marks the beginning of a new era in financial regulation as it implies the end of a 'big leap' in the asset management industry. Going forward, it means more compliance requirements, tighter risk control, and thus slower but better-quality growth."
This might go down like a cup of cold sick with Chinese savers who have become accustomed to circumventing financial repression via these products. However - and this is significant - the new regime doesn't take effect until the end of June 2019. We can only guess the delay reflects the enormity of the problems discovered by China's regulators when they finally looked under the hood.
The shadow banking measures, announced after Friday's close, hit Chinese equities when they opened Monday. However, the sharp fall in the Shanghai Composite miraculously turned around late in the day, closing up 0.3%. Either, "bargain hunters" saw a too-good-to-be-missed opportunity as Bloomberg TV implied, or the "National Team" was ordered off the bench late in the session. We think we know the answer and our sense is that the authorities are increasingly concerned about risk-taking in Chinese equity markets currently. On Friday we highlighted the warning from the state-owned Xinhua news agency that the share price of China's largest liquor maker, Kweichow Moutai, was rising too fast.
This is Bloomberg's take on the market reaction to the new shadow banking rules.
China's sweeping new plan to rein in its shadow banking industry rippled through the nation's stock market on Monday, sending the Shanghai Composite Index to a two-month low. Investors pushed the benchmark gauge down as much as 1.4 percent amid concern that the government's latest attempt to tighten supervision of $15 trillion in asset-management products will siphon funds from the market. Developers and brokerages paced losses. While analysts applauded the plan as an important step toward curbing risk in China's financial system, they also warned of turbulence as markets adjust to outflows from popular shadow-banking products.
The government directives, which are set to take effect in 2019, add to signs that President Xi Jinping is willing to sacrifice growth as he tries to put the world's second-largest economy on a more stable financial footing. "The rules dealt a blow to the market," said Zhang Gang, a Shanghai-based strategist with Central China Securities Co. "A lot of such products had positions in the equity market, and those that don't qualify under new rules may choose to exit some small and medium caps."
In the midst of the sell-off, the major losers in the real estate sector were China Vanke Co. which fell 4.9% on the wild(er) Shenzhen exchange, Poly real Estate which fell 3.2% and Gemdale Corp. which fell 2.6%. Securities dealers tumbled to a five-month low with Citic Securities sliding 3.7% at one point. Meanwhile, trading in China's government bond market was relatively civilized, with the benchmark 10-year yield rising 1 basis point to 3.97% - remaining on the "right" side of the psychologically important 4.0% level. That said, the benchmark has risen 24 basis point since the end of the Party congress on 24 October 2017.
This was Reuters' take on the new shadow banking measures.
The guidelines unified rules covering asset management products issued by banks, trust firms, insurance asset management companies, securities firms, funds and futures companies, the People's Bank of China (PBOC) said in a joint statement with the banking, insurance, securities and foreign exchange regulators…The new rules aim to close loopholes that allow regulatory arbitrage, reduce leverage levels to curb asset price bubbles and rein in shadow banking activity.
The new rules will set leverage limits for asset management products. They will cap the total assets to net assets ratio at 140 percent for open mutual funds and 200 percent for private funds. Investors will be prohibited from pledging their shares in asset management products as collateral to obtain financing, a practice that would increase leverage. The central bank also said financial institutions must break the practice of providing investors with implicit guarantees against investment losses.
Financial institutions will also be forbidden from creating a "capital pool" to manage funds raised through asset management products. The practice allows banks to roll over the products constantly. The investment losses will be implicitly covered by the new product issuance…Financial institutions will also be forbidden from creating a "capital pool" to manage funds raised through asset management products. The practice allows banks to roll over the products constantly. The investment losses will be implicitly covered by the new product issuance.
While the new shadow banking measures are obviously welcome, we fear that they are coming too late to prevent a catastrophic bursting of China's debt bubble. As we have hinted for the past 3 years, the next global crisis will probably start in China, and with Xi's role cemented for the next 5 years (if not for life) the smart thing would be to have the Chinese economic hiccup (because recession is clearly a taboo under central planning) as soon as possible, so the economy can recover by 2022.
As ever, it's the timing of China's "Minsky moment" which remains elusive. Having said that, we suspect that the Xinhua warning about Kweichow Moutai was a signal that the Chinese leadership is on high alert regarding a spike in equity volatility.
In retrospect, perhaps the Xinhua warning was not so strange: after China's debt-fueled stock market bubble burst in 2015, wiping out $5 trillion of value, Chinese policy makers have acted to restrain excessive speculation in equities. "Xinhua is concerned that a runaway rally in a heavyweight like Kweichow will hamper the stability of the overall market," said Hao Hong, chief strategist at Bocom International Holding Co in Hong Kong.
And while one can wonder why China is suddenly so concerned about even the hint of potential vol spike in the stock market - suggesting that even a modest selloff could have dramatic consequences for the Chinese financial sector - it is certainly strange that whereas even China is acting to restrain the euphoria of its citizens over fears of what happens during the next bubble, in other "developed" countries, the local central bankers, politicians and TV pundits have no problem in forcing retail investors to go all risk assets when the market is at all-time highs.
As for China, it will have truly gone a full "180", if in a few months time instead of arresting sellers as it did in the summer of 2015, Beijing throw stock buyers in prison next.